1. Field of the Invention
The present invention relates generally to financial trading systems and more particularly to the processing, valuating, and trading of financial instruments such as futures and the like.
2. Related Art
In today's financial markets, the use of financial instruments known as futures contracts are common place. Futures contracts are standardized, transferable agreements, which may be exchange-traded, to buy or sell a commodity (e.g., a particular crop, livestock, oil, natural gas, etc.). These contracts typically involve an agreed-upon place and time in the future between two parties. That is, a futures contract is supply contract between a buyer and seller, where the buyer is obligated to take delivery, and the seller is obligated to provide delivery of a fixed amount of a commodity at a predetermined price at a specified location. Futures contracts are typically traded exclusively on regulated exchanges and are settled daily based on their current value in the marketplace.
Another form of financial instruments are option contracts. Options contracts are agreements, that may be exchange-traded, among two parties that represent the right to buy or sell a specified amount of an underlying security (e.g., a stock, bond, futures contract, etc.) at a specified price within a specified time. (In relation to the present discussion, an options contract which specifies gas futures is of most interest.)
The parties of options contracts are purchasers who acquire “rights,” and sellers who assume “obligations.” Further, a “call” option contract is one giving the owner the right to buy, whereas a “put” option contract is one giving the owner the right to sell the underlying security. There is typically an up-front, non-refundable premium that the buyer pays the seller to obtain the option rights.
Options and futures contracts are explained in detail in John Hull, Options, Futures, and Other Derivative Securities, Prentice Hall (3rd. ed. 1997), ISBN 0138874980, which is incorporated herein by reference in its entirety.
Taking the example of a specific commodity—natural gas—traders typically buy and sell natural gas futures on a daily basis on the New York Mercantile Exchange (NYMEX) regulated exchange. What is commonly referred to as “natural gas” is a naturally occurring mixture of hydrocarbon and other gases found in porous rock formations. Its principal component is methane whose molecular formula is CH4. It is estimated that natural gas currently provides about 24 percent of all the energy used in the United States.
Typically, gas traders (i.e., those who buy and sell natural gas futures and options) represent the interests of utility companies and other entities who require a large supply of natural gas in order to provide energy to businesses and homes. In order to assure continuous operations, while minimizing expenses, utility companies and other entities buy and sell (i.e., trade) natural gas futures and options.
Because futures and option contracts (i.e., “gas futures”) are essentially financial instruments, they may be traded among investors as are stocks, bonds, and the like. Thus, in order to trade gas futures and options, there must be a mechanism to price them so that traders may exchange them in an open market.
The relationship between the value of a gas future or option and the value of the underlying commodity are not linear and can be very complex. Economists have developed pricing models in order to valuate certain types of futures and options. Further, many strategies exist for utility companies and other entities to predict the demand for energy and thus, the number of contracts needed over a specific period of future time. Each model and strategy has inherent flaws, and thus poses risks.
Risks in relying on any one model or strategy includes errors in the model's underlying assumptions, errors in calculation when using the model, and failure to account for variables (i.e., occurrences) that may affect the price of the underlying commodity (i.e., natural gas). For example, factors such as economics, politics, etc. play a critical role in estimating demand for natural gas.
When considering the latter risk—failure to account for occurrences that may affect price—weather is one occurrence which has been historically been overlooked. That is, weather, and more specifically future weather, has not been included as a formal variable in pricing models.
The few models that have considered weather usually have only considered past (i.e., historical) weather data. Further, strategies based on predicated demand also have only considered historical weather data. That is, most models and strategies assume, for example, that the previous year's weather and its effects on power demand will repeat from year to year. Historical analysis has shown, however, that this assumption is true only a quarter of the time. Thus, regardless of whether futures or options are being evaluated, risk management trading techniques, strategies, or vehicles, traders essentially have been operating in the “blind” without knowledge of future weather conditions.
Therefore, what is needed is a method, system and computer program product for valuating (and thus, processing and trading) natural gas futures and options contracts using weather-based metrics.